The entry today is about capital contribution and debt-to equity ratios.
When a foreign investor subscribes for the new equity in a domestic company (a non- foreign invested company), the existing shareholders of the domestic company must contribute no less than 20% of the new equity at the time the company applies for its new foreign investment enterprise business license (in this sense see Art. 16, second paragraph of the M&A Regulations 2006, excluding companies formed by way of share offer). The remaining new equity must be contributed in accordance with the requirements of the Company Law 2006 (available at the following website:
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/company/the-company-law-of-the-peoples-republic-of-china.html
) and other laws applicable to foreign invested enterprises.
When a foreign investor acquires a domestic company and establishes a FIE but will hold less than 25% of the registered capital of the foreign invested enterprise, it must make any cash capital contribution in full within three months of the date on which the business license is issued. Where the capital contribution is made in kind, it can be contributed within six months (in this sense see Art. 16 fourth paragraph, M&A Regulations 2006, available at the following website:
http://english.mofcom.gov.cn/aarticle/policyrelease/domesticpolicy/200610/20061003434565.html
). Following an equity acquisition, the foreign investor’s proportionate share of registered capital is calculated on the proportion that the acquired equity bears to the entire registered capital (in this sense, Art. 18, first paragraph, M&A Regulations 2006). Moreover, following an equity acquisition the newly established FIE must comply with the following so called debt-to-equity ratios, unless otherwise provided by law: i) If the registered capital is less than USD 2,100,000, the total amount of investment cannot exceed 10/7 of the registered capital; ii) if the registered capital corresponds to 2,100,000 or more but is less than USD 5,000,000, the total amount of investment cannot exceed twice the amount of registered capital; iii) if the registered capital corresponds to 5,000,000 or more but is less than USD 12,000,000, the total amount of investment cannot exceed 2.5 times the amount of registered capital; iv) if the registered capital corresponds to 12,000,000 or more, the total amount of investment cannot exceed 3 times the amount of registered capital.
It must be stressed that the M&A Regulations 2006 apply to an equity acquisition of, or subscription in, a foreign invested enterprise, to the extent that the Several Regulations on the Change in Equity Interest of Investors in Foreign Investment Enterprise 1997 (available at the following website:
http://www.lehmanlaw.com/resource-centre/laws-and-regulations/foreign-investment/provisional-regulations-on-the-change-of-equity-interests-among-investors-in-foreign-investment-enterprises-1997.html
) and other laws that apply to foreign investment enterprises are silent with respect to a particular matter (in this sense Art. 55, second paragraph, M&A Regulations 2006). Moreover, the M&A Regulations 2006 not only apply to a foreign investor purchasing the equity interest of a shareholder in a domestic company, or subscribing for new equity in a domestic company (to be converted into a new FIE), but also they apply to an acquisition by a foreign investor of a domestic limited liability company for the purpose of restructuring into a company limited by shares, and to acquisitions by holding companies. (and foreign invested enterprises) of a domestic company or a foreign invested enterprise to the extent that other specific laws are silent on a particular point.
At this point next time we can discuss more in detail about the differences between an assets acquisition and equity acquisition and explaining the use of the due diligence.
– CRISTIANO RIZZI